VIX Index Signals Market Paves Way to a Pullback
The stock market's momentum has waned since 2023 ended, and a potential phase for a significant market retreat has emerged.
This could happen as protective currents stemming from the expiration of major companies' options on Friday combined with U.S. Economic indicators suggest a lower number of Federal Reserve interest-rate reductions than previously anticipated by market analysts, according to Michael Kramer of Mott Capital Management.
The $CBOE Volatility S&P 500 Index(.VIX.US$ , or "Volatility Index," measures the stock market's expectation of volatility based on $S&P 500 Index(.SPX.US$ options. When the VIX rises, it indicates that traders expect the stock market to become more volatile, suggesting increased uncertainty or fear in the market. This is often seen during times of economic distress or major geopolitical events. On the other hand, when the VIX falls, it suggests that traders expect less volatility, indicating greater confidence or stability in the market. Lower VIX values are often associated with periods of economic stability and growth.
On Friday, the VIX revised lower to 13.62, after touching the 15 level briefly during intraday trading on Wednesday, which was also the expiration date for VIX monthly options.
Whether the VIX continues to move higher or lower will largely depend on macro factors and how the market adjusts to the idea that the Fed most likely won't be cutting rates six or seven times between now and January 2025, as some observers had expected. That could especially prove true if U.S. economic figures continue to come in hotter than expected, as happened with recent reports on retail sales. Non-farm payrolls and the Consumer Price Index.
The market seems to be heading into a phase where we can expect heightened volatility. This is anticipated to occur after Wednesday's expiration of VIX options, coupled with the conclusion of hedging activities for numerous large-cap stocks with their monthly options expiry on Jan. 19.
Observations indicate that markets saw a significant accumulation of put deltas in the VIX over recent weeks. These put deltas generate downward pressure on the VIX as investors purchase puts and market makers take the opposite side of the trade. To hedge their positions against a potential decrease in implied volatility, market makers must then shorten the VIX or the implied volatility itself. This is because in selling puts, market makers are, in effect, assuming a position that's bullish on implied volatility.
This is one of the major reasons why the VIX has been mostly stuck below 14 since Dec. 21. But now that Wednesday's VIX option expiration is behind us, the indicator might be more free to move back above 14.
Additionally, it's noteworthy that many mega-cap tech stocks, such as $NVIDIA(NVDA.US$ and $Meta Platforms(META.US$ , have experienced positive cash inflows, which may be the reason for their sustained rise over the past few weeks.
Call-option deltas for these stocks have been built up over the past few months. While the overall market positions remain undisclosed, the number of open call-option contracts and the price movements for stocks like Meta and Nvidia suggest that extensive hedging activities are underway, assisting in maintaining strong bids for these stocks.
Suppose clients purchase call options on Meta, and the market makers sell those call options. The market makers essentially become short on Meta. This means that the market makers need to hedge against the risk of Meta's stock price rising.
There are several ways to hedge, but the most fundamental form involves holding shares of Meta. As Meta's stock price increases, the value of the call options also goes up, necessitating that market makers buy more Meta shares to maintain delta neutrality. This creates a loop that can drive the stock price continually higher.
Source: Bestinbusiness
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